Macroeconomic priorities revisited: the behavioural foundations of stabilization policies

Fabio D’Orlando and Francesco Ferrante ()

Cambridge Journal of Economics, 2018, vol. 42, issue 5, 1255-1275

Abstract: The theoretical literature that neglects the benefits of stabilization policies (e.g., Lucas 1987, 2003) ultimately relies on the low impact of macroeconomic volatility on aggregate income and consumption. We argue that this conclusion is theoretically and empirically weak. Theoretically, the cost of volatility should be measured by including not only monetary magnitudes, but also those psychological costs whose relevance has been stressed by behavioural economics and that are correlated with the number of unemployment episodes. We refer here to implications for the experienced utility of loss aversion, the endowment effect and hedonic adaptation. Empirically, downturns more severely affect those who have less and who suffer greater well-being losses from each shock, magnifying the negative impact of recessions. It follows that the traditional analysis, which disregards the main causes of well-being losses determined by downturns, cannot represent a sound basis for dismissing policies aimed at preventing downturns (and/or their impact on the labour market).

Keywords: Behavioural economics; Employment protection legislation; Endowment effect; Hedonic adaptation; Loss aversion; Recessions; Redistribution; Unemployment (search for similar items in EconPapers)
Date: 2018
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